Viewpoint: 'The R&D credit doesn't work'

The R&D tax credit does not increase U.S. R&D expenditures, and the $10 billion we spend each year on the credit is mostly a financial transfer from the government to large multinational corporations with no benefit to U.S. taxpayers.

The R&D tax credit expired on Dec. 31, 2011, and its passing produced hardly a noticeable ripple throughout the high-tech industry. That’s not because American business doesn't miss the financial benefits from this tax incentive, but because many companies understand that it’s only a matter of time until Congress again revives it. Congress has frequently let the credit expire, then acted to reinstate it retroactively.

But what is the value of this credit? And does it make sense for Congress to restore it?

The research credit has been in existence for over 30 years. During that time, not one company has announced an invention or product that was produced as a result of the R&D tax credit. Unlike government subsidies that have gone to the Defense Advanced Research Projects Agency, the National Science Foundation or the Energy Department, we taxpayers have nothing to show for our investment in the research credit.

Michael Rashkin

The reason is fairly obvious: Companies do not undertake research projects because of a small tax subsidy. Instead R&D projects are initiated because companies need them to compete in a global market and they will engage in research regardless of whether or not a tax credit is available.

The credit is calculated as a percentage of R&D wages, and the percentage can be either 20 percent or 14 percent, depending on how a company computes the credit. But the impact of many restrictions imposed by Congress effectively means the credit generally amounts to only about 5 percent of research expenditures, hardly enough to make a company engage in research it otherwise wouldn’t undertake.

Congress imposed restrictions to reduce the cost of the credit, but at same time these limitations diminish its effectiveness. Despite its weak effect, the credit is expensive, costing taxpayers an estimated $10 billion per year.

The original purpose of the R&D tax credit was to increase research expenditures, and many economic studies claim that the credit increases research expenditures on a one-to-one basis, meaning that for each dollar of credit there is one additional dollar of R&D expenditure. These studies are contrafactual, or what-if calculations. They look backward and try to determine what would have happened if there were no research credit.

Although supporters of the R&D tax credit trumpet these studies as evidence of that the credit is working, a one-to-one ratio is actually evidence of ineffectiveness. An effective incentive should have a multiplier effect, providing an increase of $3 to $4 of R&D for each dollar of credit. Moreover, these studies do not square with the failure of companies to demonstrate that any additional research was undertaken because of the credit. For $10 billion in credit, it is fair to ask to see some concrete results.

Part of the problem with the research credit is that it goes to companies that do not need it. Over 80 percent of the credits earned go to very large companies. Apple, Google, Microsoft and Intel already have billions of dollars in the bank, and are therefore unlikely to increase their R&D expenditures as a result of a small tax incentive. On the other hand, start-ups that can use additional financing do not benefit from the credit since they are not profitable and have no tax liability against which they can apply the credit.

The U.S. government has been very generous to the high technology industry. In addition to financing a large portion of basic research, thereby saving industry the expense, Washington allows a 100 percent tax write-off of R&D expenditures, and allows companies to transfer their intangible property rights to offshore tax havens. It is therefore not surprising that companies manufacture their products offshore since doing so allows them to avoid U.S taxes on their manufacturing profits.

To give these companies a research credit in addition is to reward, in many cases, behavior that is detrimental to the U.S. economy.

The economic theory supporting the R&D tax credit is that companies do not fully capture all the returns resulting from an invention and, as a consequence, market forces do not provide adequate stimulus for R&D activity. It is therefore argued that it is the role of the government to compensate for this market failure by providing a tax subsidy.

While this theory does not square with free market economics, that fact has not stopped members of Congress from both parties along with the president from enthusiastically supporting renewal of the credit. In fact, as the centerpiece of his science and technology policy, President Obama has recently proposed increasing the amount of the tax credit while extending it 10 years.

The R&D credit does not increase R&D expenditures, and the $10 billion we spend each year on the credit is mostly a financial transfer from the government to large multinational corporations with no benefit to U.S. taxpayers. It is not the federal government’s responsibility to finance or subsidize the ordinary business activities of corporations, especially when that subsidy does not provide the desired effect.

Now that the R&D tax credit has expired, it’s a good time to let it be.

--Michael Rashkin is a tax attorney who has worked in the high-tech industry for more than 40 years, including 13 years at Apple and 12 years at Marvell Semiconductor. The opinions expressed here are his alone, and do not reflect those of any organization.

PART 6
In reality, the R&D tax credit has barely been given a chance to work. With an average extension duration of less than 2 years since its creation, the credit has been so unreliable that companies would be crazy to develop long-term spending plans around it. Once the credit is renewed for five years or more, or even permanently, companies will have a better how to incorporate it into their plans -- especially if it is simplified along the lines that Laura Tyson, Rob Atkinson, myself, and others have been advocating.
In short, Rashkin’s complaints about the credit don’t stand up to the evidence. US innovation is vital for US economic growth and is too important to play games with. The R&D tax credit needs to be renewed, improved, and extended.

PART 5
Rashkin turns reality on its head by claiming that the credit rewards “behavior that is detrimental to the U.S. economy”. That’s just silly. The credit rewards the performance of R&D in US-based labs by any company, including foreign multinationals. The presence of that R&D in the US has value in itself (e.g., providing incentives for students to choose majors in science and technology because they can see a future in it) that is totally separate from the very important issues surrounding the long-term decline in US manufacturing. The R&D tax credit cannot be blamed for the steady shift to offshore manufacturing, and the credit’s loss, which can only speed the parallel movement offshore of R&D, will do nothing to bring manufacturing back.

PART 4
Rashkin complains that the credit does not have a "multiplier effect". But the multiplier effect here does not operate at the company level; it operates at the level of the economy. It has been shown that every dollar of business R&D spending has about twice as big a benefit for other parts of the economy as it does for each firm that spends it. This economy-wide impact is above and beyond the dollar-for-dollar impact that, by itself, justifies the credit’s continued existence.
In other words, left to itself, industry will, from society’s perspective, invest too little in research. Rashkin dismisses this because it “does not square with free market economics”. This is a nonsensical statement because the whole point about recognizing that firms underinvest in R&D from the standpoint of the economy as a whole is that it is a failure of the “free market” ideal to which Rashkin refers.

PART 3
The fact that the credit goes mostly to large companies with good cash flow simply reflects that large companies do most of the R&D. The tax credit in its current form is designed to reward a targeted activity, R&D, at profitable, tax-paying companies, not to help out cash-constrained companies. So again, this criticism accuses the credit of falling short of a target it was never designed to reach.
One point where we agree is that the credit should be made more attractive to small companies and start-ups. That was part of the proposals in a report I co-authored with Laura Tyson for the Center for American Progress. The full report can be downloaded at http://www.americanprogress.org/issues/2012/01/corporate_r_and_d.html

PART 2
Rashkin implies that credit should cause companies to increase research spending by multiple times the amount of the credit. But the dollar-for-dollar increase in R&D spending (compared to the tax cost of the credit) is no sign of failure. Many other subsidies only cause companies to move money from one account to another, without increasing spending. Here we have one that has been documented by multiple studies to actually increase R&D spending, and in a way that allows firms, not government bureaucrats, to choose the projects where that money is spent.
The claim that the credit is "hardly enough to make a company engage in research it otherwise wouldn’t undertake" flies in the face of the careful studies that show the contrary. Particularly at a time when a slow economy is causing many companies to trim their R&D budgets to the bare minimum, it seems like a stretch to claim that an effective 5 percent rebate (Rashkin’s number) could fail to have an influence.

PART 1
It's easy to claim, as Michael Rashkin does, that the R&D tax credit falls short of some mythical ideal. But the facts show that the credit does what it was designed to do: measurably increase the level of US R&D spending. No one is claiming that the tech industry will be lost without it. The claim from those, like myself, who study the credit from the academic side is that the US will be poorer in the long run without it.
The fact that no company "has announced an invention or product that was produced as a result of the R&D tax credit" is meaningless. The credit is not targeted on a project-by-project basis. In practice, most large companies (the ones that perform the most R&D) choose a level of spending with the credit in mind, then allocate to separate projects later. So there will never be a project that is directly linked to the credit.

The author makes an excellent point here:
"...Part of the problem with the research credit is that it goes to companies that do not need it. Over 80 percent of the credits earned go to very large companies. Apple, Google, Microsoft and Intel already have billions of dollars in the bank, and are therefore unlikely to increase their R&D expenditures as a result of a small tax incentive. On the other hand, start-ups that can use additional financing do not benefit from the credit since they are not profitable and have no tax liability against which they can apply the credit."
So...obviously, the usual lip-service to "the increase in R&D credit" ain't working!

"...the $10 billion we spend each year on the credit is mostly a financial transfer from the government to large multinational corporations with no benefit to U.S. taxpayers."
In reality, this is a financial transfer from U.S. taxpayers to large multinational corporations. Theft will never lead to sustainable prosperity.

The author, a tech industry veteran, makes a compelling case that the U.S. R&D tax credit is a bust, resulting in virtually no new investment in U.S. innovation. We have argued that any renewal of the tax credit should be tied to strict requirements for investing in U.S. design and manufacturing. Michael Rashkin thinks we should just let the R&D credit die.